The World is Turning Japanese [Chart]
Negative rates, Kuroda’s “Peter Pan” analogy, and gold’s surge
The Chart of the Week is a weekly Visual Capitalist feature on Fridays.
Nearly a year ago, Bank of Japan governor Haruhiko Kuroda described the unlikely inspiration behind Japan’s unprecedented monetary stimulus: Peter Pan.
I trust that many of you are familiar with the story of Peter Pan, in which it says, ‘the moment you doubt whether you can fly, you cease forever to be able to do it’. Yes, what we need is a positive attitude and conviction. Indeed, each time central banks have been confronted with a wide range of problems, they have overcome the problems by conceiving new solutions.
Kuroda’s optimism is desperately needed in a country that has now been officially “leapfrogged” by the four Asian Tigers in terms of Real GDP per capita (PPP). With over a decade of experimentation in extreme monetary policy under their belts, Japan has very little to show for it.
It would be fine if this story of economic malaise could be confined as a global outlier. However, recent circumstances have prodded the world’s central bankers to finally buy into the tale of Peter Pan.
The world is turning Japanese.
So Much Negativity
Negative interest rates were an economic pipe dream many decades ago, but the idea of “charging” interest to hold money is now becoming mainstream. Conventional wisdom was that depositors would just hoard cash rather than depositing at a cost, but now the people running central banks are beginning to believe that this fear is misplaced. Especially as society becomes more cashless, the inconvenience of withdrawing money to save a few bucks isn’t worth it.
Central banks in Switzerland, Sweden, Denmark, and Japan now all have negative interest rates. The ECB has also held their Deposit Facility Rate for overnight deposits in the negative since June 2014.
In recent weeks, the interest in this economic experiment has risen significantly. Sweden cut their rates deeper into negative territory, signalling to the rest of the world that there is nothing to fear. Meanwhile, both the Federal Reserve and the Bank of Canada have openly pondered the possibility of NIRP in their respective jurisdictions.
Not everyone agrees with the central bankers in seeing the Peter Pan analogy to be a fitting representation.
We’d liken it more to a squad of musketeers running out of gunpowder, and turning desperately to their bayonets to win a decision. It doesn’t matter how much conviction and optimism the crew has in their bayonet skills – at the end of the day, it’s only going to add a few extra minutes of life into the inevitable battle against a much more powerful deflationary force.
In other words, “hope” isn’t a strategy that central bankers can use to any efficacy, and wishful thinking can only go so far. The market seems to agree, and it’s part of the reason that stocks have sold off this year. Even the “safe haven” gold trade is back, after being absent for much of the previous year.
Many critique assets such as gold, which is up 15% year-to-date, because it does not pay a dividend or interest.
This may be true, but at least gold does not “charge” interest, as bankers across the world are beginning to ponder.
The Periodic Table of Commodity Returns (2021 Edition)
Which commodity had the best returns in 2020? From gold to oil, we show how commodity price performance stacks up over the last decade.
The Periodic Table of Commodity Returns (2011-2020)
Being a commodity investor can feel like riding a roller coaster.
Take silver. Typically known for sharp, idiosyncratic price movements, it faced double-digit declines in the first half of the decade, falling over 35% in just 2013 alone. By contrast, it jumped over 47% in 2020. Similarly, oil, corn, and others witnessed either steep declines or rapid gains.
The above graphic from U.S. Global Investors traces 10 years of commodity price performance, highlighting 14 different commodities and their annual ranking over the years.
Commodity Price Performance, From Best to Worst
Which commodities were the top performers in 2020?
The aforementioned silver tripled its returns year-over-year, climbing 47.9% in 2020. In July, the metal actually experienced its strongest month since 1979.
Along with silver, at least seven other commodities had stronger returns than the S&P 500 in 2020, which closed off the year with 16.3% gains. This included copper (26.0%), palladium (25.9%), gold (25.1%) and corn (24.8%).
Interestingly, copper prices moved in an unconventional pattern compared to gold in 2020. Often, investors rush to gold in uncertain economic climates, while sectors such as construction and manufacturing—which both rely heavily on copper—tend to decline. Instead, both copper and gold saw their prices rise in conjunction.
Nowadays, copper is also a vital material in electric vehicles (EVs), with recent demand for EVs also influencing the price of copper.
As investors flocked to safety, silver’s price reached heights not seen since 2010.
The massive scale of monetary and fiscal stimulus led to inflationary fears, also boosting the price of silver. How does this compare to its returns over the last decade?
In 2013, silver crashed over 35% as confidence grew in global markets. By contrast, in 2016, the Brexit referendum stirred uncertainty in global markets. Investors allocated money in silver, and prices shifted upwards.
As Gold as the Hills
Like silver, market uncertainty has historically boosted the price of gold.
What else contributed to gold’s rise?
- U.S. debt continues to climb, pushing down confidence in the U.S. dollar
- A weaker U.S. dollar makes gold cheaper for other countries to buy
- Low interest rates kept the returns of other safe haven assets low, making gold more attractive by comparison
Here’s how the price of gold has changed in recent years.
Gold faced its steepest recent declines in 2013, when the Federal Reserve bank discussed tapering down its quantitative easing program in light of economic recovery.
Hitting the Brakes On Oil
Oil suffered the worst commodity price performance in 2020, with -20.5% returns.
For the first time in history, oil prices went negative as demand plummeted. To limit its oversupply, oil producers shrunk investment, closed wells, and turned off valves. Unfortunately, many companies still faced bankruptcies. By November, 45 oil producers had proceeded with bankruptcy filings year-to-date.
This stood in stark contrast to 2019, when prices soared 34.5%.
As is custom for oil, prices see-sawed over the decade. In 2016 and 2019, it witnessed gains of over 30%. However, like 2020, in 2014 it saw huge losses due to an oversupply of global petroleum.
In 2020, total production cuts hit 7.2 million barrels a day in December, equal to 7% of global demand, in response to COVID-19.
Why Gold Mining Stocks Outperform Gold in Bull Markets
Gold mining stocks outpace gold returns in bull markets, but how? With higher gold prices, miners get ahead thanks to operating leverage.
Why Gold Mining Stocks Outperform Gold in Bull Markets
Gold is highly revered for its great returns and resilience during economic downturns, but during gold bull markets there’s something that regularly provides even greater returns: the ownership of gold mining stocks.
Over the past 20 years, gold mining stocks have outperformed the price of gold bullion in bull markets, offering what can be seen as a leveraged play on gold’s price appreciation.
While gold miners offer more potential upside, they also have higher volatility and greater downside during dips, making market timing and strong hands all the more important.
This infographic comes to us from Sprott and compares the returns of gold stocks and gold bullion in bull markets. It also explains how gold stocks outperform thanks to profit expansion, and shows why there might be more upside for gold miners to come.
How Operating Leverage Benefits Gold Mining Companies
During the 2000-2011 gold bull market, the price of physical gold rose 550%. While you might think that number is hard to beat, over the same period of time gold mining equities (represented by the NYSE Arca Gold Miners Index) returned more than 690%.
In the current gold bull market which started in 2015, gold mining stocks are up more than 182%, more than doubling gold bullion’s 78% returns.
This outperformance in bull markets is largely due to how gold mining companies use their operating leverage to maximize profits, resulting in their share prices appreciating.
Breaking Down Gold Mining Costs and Profits
As a gold mining company mines and produces gold, the gold is sold on the market fairly quickly to avoid the risk of gold’s price depreciating.
When the price of gold rises, miners immediately start to see greater profits from selling their ounces on the market. While the costs to mine gold also rise in bull markets, they rise less and at a slower rate.
The result of this is profit expansion: when operationally efficient gold mining companies are able to capture larger profits, resulting in increased operating and free cash flow.
Breakdown of Barrick Gold’s Profit per Ounce of Gold
|Year||All-in Sustaining Costs/oz (in USD)||Realized Gold Price/oz (in USD)||Profit/oz (in USD)|
During the current gold bull run which started in 2015, Barrick Gold’s average realized price per troy ounce of gold increased by 50%, while their all-in sustaining costs per troy ounce only went up by 18%.
This has resulted in the company increasing their profit per ounce of gold sold by a staggering 134% over the past six years.
Making the Most of Golden Times
While higher profit margins during bull markets are great, it’s up to the individual company to ensure the extra cash is being used prudently to efficiently support their operations.
Bull markets don’t last forever, and gold miners must use these prosperous times to strengthen their balance sheets, reward shareholders, and reinvest into projects which will provide future value and returns.
Dividend-paying gold stocks increase dividends to reward loyal shareholders, with the average dividend increase of top gold mining stocks in a bull market often doubling.
Over the decades, companies have gotten better at making the most of bull markets in order to be well-guarded for when gold prices stop appreciating, and eventually start declining.
Why Gold Mining Stocks May Still Be Undervalued
Even if gold mining stocks have already seen impressive returns over the past five years, there are some technical indicators which point to them still being undervalued compared to other equities and gold bullion.
- The top 10 gold mining companies have seen their earnings per share estimates almost triple in the past two years.
- The top 20 S&P 500 companies have seen around a -15% decline in their earnings per share estimates.
Along with having better earnings per share compared to the top U.S. equities, gold mining stocks may also be undervalued compared to gold bullion.
The gold mining stocks to gold bullion ratio is at historically low levels after having dropped more than 60% following the 2008 financial crisis. While gold bullion is increasingly seen as a safe haven asset for investors, gold miners are still overlooked despite their strong technicals.
Gold and Gold Miners’ Role in the Future Economy
As money printing has been the Federal Reserve’s main answer to an increasingly volatile economic climate, gold and its producers are set to play a crucial role in helping investors preserve their wealth.
Gold has yet again outperformed just about every other asset class in 2020, and gold miners offer even greater returns for those willing to manage the additional risk they present.
Gold mining stocks are much more volatile compared to gold bullion, and have a variety of additional risks dependent on their company structure, jurisdiction of operations, and operational efficiency. But for investors who are looking for exceptional returns in gold bull markets, they can be an alluring option.
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